EXHIBIT B Statement of income, Jan. 1, 1963, through Nov. 15, 1963, with comparative figures for the period June 1, 1962, through Dec. 31, 1962 NOTES TO FINANCIAL STATEMENTS, NOVEMBER 15, 1963 1. Securities pledged as collateral.-U.S. Government securities having an amortized cost of $10,014,575.71 are pledged as collateral for public time deposits and the Treasury tax and loan account. 2. Leasehold improvements and furniture and equipment.-A summary of leasehold improvements and furniture and equipment is shown in the following comparative tabulation: Leasehold improvements are stated at cost less allowance for amortization accumulated over the terms of the leases. Furniture and equipment is stated at cost less the 7 percent investment credit allowable for Federal income taxes aggregating $23,592.47. Depreciation is accumulated based upon an estimated 10-year life with a 5-percent remaining salvage value. 3. Federal income taxes.-Under the Internal Revenue Code of 1954 the bank is allowed a bad-debt-reserve deduction. The amount of such deduction may be established each year at the discretion of the bank's directors, up to the full amount of what would otherwise be its taxable income, so long as such annual deduction does not exceed a percentage of loan balances (as defined) outstanding at the close of the taxable year based upon the experience of all member banks of the 12th Federal Reserve district. Further, the ratio of the net aggregate reserve balance to loans outstanding shall not exceed three times the annual rate. For the period January 1, 1963, through November 15, 1963, the bank made provision for bad debts amounting to $116,819.80. Such provision is within the allowable limitations. Preliminary calculations indicate that there will be no taxable income for 1963 after the application of the loss carry forward available to the bank from the previous year. 4. Voting trust agreement.-A voting trust agreement dated February 21, 1962, between certain stockholders of the bank and selected trustees (primarily directors) was created to "develop properly the rights, privileges, franchises, property, and earning capacity of the bank." The term of the agreement was for 7 years to February 23, 1969. Of the 150,000 shares of common stock outstanding at November 20, 1963, 98,115 shares held by 375 shareholders had been exchanged for trust certificates in accordance with the terms of the voting trust agreement. 5. Long-term leases.-The bank is obligated under certain long-term leases for bank premises in San Francisco as follows: 1 Includes all option to renew periods. * Basic annual rental exclusive of taxes and other expenses payable under the leases. We maintained control over subsidiary accounts from which confirmations were selected and all reported exceptions were satisfactorily reconciled. All confirmation requests returned by the post office as undeliverable were remailed to better addresses except for eight savings accounts, and four checking accounts which were turned over to management for proper disposition. Of the accounts selected for confirmation, four were designated as "no mail." We verified such classification by reference to authorizations on file and such accounts were sealed and turned over to management for disposition to the depositor. We examined notes to the extent we deemed necessary giving due regard to the system of internal control and confirmed outstanding principal balances together with the related collateral directly with borrowers to the extent indicated on the confirmation summary. All negotiable collateral was inspected by us and traced to the collateral records as of the audit date. We reviewed the report of examination as of May 20, 1963, made by the Controller of Currency and noted that the bank has taken corrective action where necessary. We followed up on loans classified as "doubtful" or "loss" by the Controller of Currency amounting to $71,562.82 and ascertained that such loans were written off to the allowance for doubtful loans or recovered. In addition, we followed up on loans classified as "substandard" and noted that of the $145,814.67 listed in this category all had been paid off or refinanced with additional borrowers or security. We analyzed property accounts, inspected documents pertaining to additions and determined that reasonable provision was being made for depreciation and amortization. We reviewed all other assets and liabilities making analysis and tests to the extent we deemed necessary and determined that they were fairly stated. The extent of the liabilities were ascertained by analyzing and testing accounts payable and other accrued expenses. In this connection, we communicated directly with the bank's legal counsel and determined by inquiry of management that there were no lawsuits or occurrence, threatened or pending, that would have an adverse material effect on the bank's financial position. Sufficient tests were made of computations of interest on loans and time deposits to satisfy ourselves that such income and expense were reasonably stated. We reviewed and tested, analyzing in detail where necessary, income and expense accounts, and were satisfied that income was properly recorded and that expenses appear to be in order. Tests were made of detail postings to the general ledger and various subsidiary ledgers. Footings of the ledgers and books of original entry were also tested. The minutes of the board of directors and stockholders' meetings were reviewed for the period for matters of general policy and other financial transactions. We reviewed the system of internal control and will submit a separate letter setting forth our suggestions and recommendations for improvement thereof. The scope of our test work was based upon the internal control. APPENDIX SCOPE OF AUDIT, NOVEMBER 15, 1963 The scope of our audit included an examination of the assets and liabilities of the bank at November 15, 1963, and of the income and expense accounts for the period January 1, 1963, through November 15, 1963. We made such tests and examinations of the accounts and other supporting data as we deemed necessary to satisfy ourselves as to the general accuracy of the accounts except that we did not evaluate the adequacy of the reserve for future loan losses. Cash on hand as of the close of business November 15, 1963, was verified by surprise counts. Local clearings and out of town transit items were confirmed directly to us by clearing house members and correspondent banks. We reconciled all bank accounts as of the audit date and the bank balances were confirmed directly to us by the depositary banks. Unissued consignments of U.S. series E bonds and travelers checks were counted by us and such counts were confirmed directly to us by the consignors. Investments in U.S. Government obligations were counted by us to confirmed directly to us by the safekeeping agency. We confirmed the Federal Reserve bank stock certificate with the Federal Reserve Bank of San Francisco. Simultaneously with our cash count, we prepared or supervised the preparation of trial balances of all subsidiary accounts. The trial balances were agreed to the related general ledger control accounts, and we requested direct mail confirmations of a portion of the loans and deposits as of November 15, 1963, as detailed below. Mr. MULTER. Mr. Chairman, is there any indication there that any information was withheld from those auditors? Mr. SAXON. Nothing whatsoever. The CHAIRMAN. Mr. Multer, the public accountant's report is unmistakably clear to persons at all familiar with financial statements and opinions expressed thereon by certified public accountants. The qualification and complete disclosures by the public accountants was related to the banks' loan portfolio. Mr. SAXON (reading) : It is our opinion that in respect to other than the adequacy of reserve for future losses on existing loans and its effects, if any, on the financial position of the results of the operations That is only the reserve for loan losses the financial statements are fairly stated in conformity with generally accepted accounting principles applied on a basis consistent with that of the preceding period Now, Mr. Chairman, to which they gave a complete and unqualified clean bill of health but in view of the fact that we were not in a position to evaluate the adequacy of loan reserves, we are unable to express an overall opinion on the accompanying financial statement. The CHAIRMAN. That is exactly my point regarding the meaning of the public accountant's opinion. You just quoted the opinion that the auditors were not in a position to evaluate the loan reserves and therefore refuse to give an opinion on the accompanying financial statement, or even to vouch for the bank's solvency. At November 15, 1963, about $31 million of a total of about $52 million in assets were classified as loans and discounts. The allowance on reserve for doubtful loans was less than $3,000 or about onehundredth of 1 percent. Without an evaluation of about 60 percent of the assets, how could anyone have an opinion? Mr. SAXON. This raises a serious question of the value of this type of audit. The CHAIRMAN. You didn't get a letter from the auditors complaining about not being permitted to see the loan portfolio. Mr. SAXON. No, sir; we didn't. The CHAIRMAN. You are sure of that? Mr. SAXON. Yes. At least it would have been brought to my attention. The CHAIRMAN. We have a bill coming up immediately at 12 under the 5-minute rule. We have to be there. Thank you very much. Mr. SAXON. Mr. Chairman. Thank you. The CHAIRMAN. We will call you back if necessary. Without objection, additional questions may be submitted to Mr. Saxon in writing for the record. Any germane documents or materials may also be inserted into the record. The CHAIRMAN. The hearing is recessed. (The following information was submitted for the record:) LETTER TO CHAIRMAN PATMAN FROM THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS REFUTING COMPTROLLER SAXON'S CONTENTION THAT THE NOVEMBER 15, 1963, AUDIT REPORT OF THE SAN FRANCISCO NATIONAL BANK GAVE THE BANK A "CLEAN BILL OF HEALTH" AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, Hon. WRIGHT PATMAN, Chairman, Committee on Banking and Currency, DEAR MR. PATMAN: As requested by your letter of July 9, I have tried, in the following paragraphs, to explain in layman's language the meaning of the audit report of Peat, Marwick, Mitchell & Co. on the November 15, 1963, financial statements of the San Francisco National Bank. As only the committee on auditing procedure (21 members) can speak officially on behalf of the institute on matters of reporting, this letter represents my own personal views. It seems clear that the auditor in this report has stated that he examined the items on the balance sheet and income statement with one exception-the reserve for future loan losses. In other words, the work he performed on the loan portfolio was limited. He ascertained the existence of the loans, but he did not determine what provision for losses, if any, would be necessary to provide an adequate reserve to cover possible future losses on existing loans. Because of the limitation on the scope of his examination, he is, in effect, saying "We are satisfied with the items we examined, but we don't know whether the reserve is adequate or not. Possibly, it may be materially understated. Since an inadequacy in the reserve could cause significant changes in the balance sheet and income statement, we just do not know whether the financial statements accurately show the bank's financial position and net income." The contention that the bank was given a "clean bill of health," I believe, is not a reasonable interpretation of the auditor's report. The auditor clearly states in the second paragraph of his report “* * * in view of the fact that we are not in a position to evaluate the adequacy of loan reserves, we are unable to express an overall opinion on the accompanying financial statements." I believe this wording is sufficiently plain to inform all readers of the report that an unresolved question exists concerning the financial statements as a whole; that is, the adequacy of the loan loss reserves. I am enclosing a copy of "Forty Questions and Answers About Audit Reports," published by the American Institute of Certified Public Accountants in 1956. I believe that you will find this booklet of interest, particularly the discussion of a disclaimer of opinion, starting on page 7. Also enclosed is a copy of "Statements on Auditing Procedure No. 33," "Auditing Standards and Procedures," published by the AICPA in 1963. This is a pronouncement of the committee on auditing procedure. Although it was prepared for practicing accountants, I believe you may be aided by the explanations in chapter 10, paragraphs 14-16 and 30-31 regarding disclaimer of opinions and limitations on scope of examination. I hope that this letter will be of some help to your committee. If you desire any further information after reviewing these comments please let me know. Respectfully yours, RICHARD A. NEST, Director of Technical Services. (Whereupon, at 11:50 a.m., the committee was adjourned, to recon vene subject to the call of the Chair.) |